What’s really in your EBITDA? 2,021 add-backs

Huw Simpson
+Justin Rampersad

30 September 2021•8 min read

The debate surrounding EBITDA’s use as a financial metric is well covered, however it does remain relevant as an industry standard for calculating leverage (among other covenant tests). Add-backs allow greater flexibility for firms - or sponsors - to incur debt, to make restricted payments or permitted investments as well as several other considerations.

In addition, its use in comparing transaction multiples means attention must still be paid to the term’s evolution, and where varying definitions or add backs cloud the picture for investors. Here we explore a few of the interesting trends and single names throughout 2021.

Our Method

We break out add-backs into the following categories, which together sum to the ‘marketed EBITDA’ figure used by a company for leverage purposes:

A: Clean EBITDA + non cash costs. We define clean EBITDA as the sum of its constituents; net income before interest costs, tax, depreciation and amortization. Non cash costs include (but are not limited to) provisions, share based payments, gains and losses, and unrealized exchange rate changes.
B: Exceptional items typically include M&A costs, fees, ‘non-recurring’ costs, and run-rating of businesses already acquired.
C: Cost synergies include those costs the company expects to save over the stated horizon.
D: More aggressive Profit synergies include the additional profit a company expects to generate over the stated horizon.
E: Finally, Covid related add-backs are those explicitly mentioned, and include costs associated with PPE, lower margins or exceptional logistic costs.

The Big Picture

Below we have compiled the results of high yield deals marketed this year, with data for 97 companies (where documentation available, excluding MTN deals and those using pre-covid figures).

After adding back non-cash costs to clean EBITDA, the average add-back in 2021 deals was 20.2%, this equates to an average leverage understatement of 0.85x. Now those figures don’t seem too bad. If we instead look at the ‘top 10’, the average add-back swells to 88.6% (leverage impact of 3.57x). For the ‘top 20’, and ‘top 30’, this is 63.1% (2.62x) and 50.7% (2.09x) respectively.

Contributions to Marketed EBITDA for the deals in our sample (excluding those with negative add-backs) can be seen below. We have truncated the x-axis to show the constituents more clearly:

Before turning to categories B through E, we first look at some interesting elements highlighted in 2021 M&A deals.

LBOs

Across our sample, Marketed EBITDA in this year's Euro LBOs range from €53.9m in Lutech’s debut €275m 5.00% SSNs (including add-backs of €20m), to €412.6m in paper maker Ahlstrom-Munksjö’s take-private by Bain Capital (including add-backs of €89.9m).

Cedacri, whose reported EBITDA almost doubles in the marketed figure, include ~ €50m in cost related synergy add-backs (staff cuts, revamping operations and improved price terms with vendors). And while the group states ~40% of these synergies have already been actioned, they estimate it will cost €16m-21.5m over two years to realize the savings. It’s one thing to ignore the costs associated with generating ongoing synergies (note EBITDA add-backs are uncapped and have no time limit in this deal), but perhaps unjustified where the synergies are one-time gains, as with the €20.1m vendor optimization.

Ahlstrom-Munksjö also deserves further attention. Alongside moderate transaction and restructuring costs, some €35m of cost synergies are added, and €30m of expected profit synergies. Even today, adding back revenue or profit synergies is relatively rare - of the companies we tracked this year, just 14 recorded these add-backs (more on this below).

Acquisitions

Across our sample, Marketed EBITDA in this year's Euro Acquisitions range from €76.6m in Swedish Transcom’s €315m E+525 floater (including add-backs of €20.9m), to €1,503.7m for Nexi (Payments) €2,100m SUNs (including add-backs of €637.2m), used to refinance existing debt of Nets and SIA.

Nexi (Payments) ‘Pro Forma Run Rate Normalized EBITDA’ is a mouthful, and contains similar disclosure issues to Solenis (discussed below), with €380.2m of ‘non-recurring expenses and income’ - not broken out. In addition, of the €270m in synergies identified for the Nets and SIA merger, around €75m are revenue synergies. The group expects to achieve 90% of these savings by 2024, four years after the Dec-2020 numbers the deal was marketed on.

Double BB rated, French environmental service group Derichebourg had a more staid approach. Although docs allow for unlimited add-backs and an 18-month time limit, adjustments for the acquisition of Ecore Group are just €21m, expected to be realized within a year, and are detailed in full. Again however, boilerplate warnings are in place stating that the group may be unable to achieve these savings, and that (unspecified) costs could exceed the benefits.

Category B: Exceptional Items

While attention is usually given to how achievable various cost or profit synergies might be, the devil often lies in other exceptional items.

Swedish-based building installation group Assemblin included a remarkable 84% of exceptional cost add-backs in their acquisition financing of Fidelix back in February. Items were mainly restructuring related (closing branches, associated legal fees, redundancies), but also full year impacts of run-rating acquisitions. For highly acquisitive companies like Assemblin, who operate a buy-and-build model, constant run-rating effectively shows the next year's profitability. This should be differentiated from large, single transformative acquisitions, where investors can view the new combined entity as a relatively steady prospect going forward.

Although not a new complaint, it’s also worth mentioning disclosure on EBITDA reconciliations. In Platinum Equity’s recent LBO of Solenis (and proposed Siguara merger) pro forma combined EBITDA of the two groups was $340.3m. Marketed EBITDA was $612.8m. Among a host of additions, over $100m was assigned to ‘other separation and non-recurring expenses’ - this is not transparent.

Another element of contention is in the sponsor fees - Solenis bagged $11.9m in their recent transaction. Although fees incurred by sponsors bidding for a company are necessarily ‘sunk’, and so legitimately ‘one-off’, you might argue this should be a cost to the sponsor, and not charged to the company in the first instance - after all, what about the expenses incurred by unsuccessful sponsors? Perhaps more contentious are the ongoing fees paid to shareholders, Parts Europe (Autodis) detailed fees of €1.5m-€1.7m paid annually to sponsor Bain Capital over the prior three years. This is clearly not an exceptional expense, but an ongoing one to provide management and consulting services. Picard recorded a similar ‘management fee’ add-back of €3.2m in its Jul-2021 refi-recap.

Of course sometimes it’s not an add-back, but simply an addition to EBITDA. Roll up of US-based Midland Credit Management and UK-based Cabot, Encore Capital includes ‘collections applied to principal balance’, which makes up half of the marketed figure, knocking off around two turns of leverage.

Category C&D: Synergies

Across the 97 deals we analysed, 30 state a form of cost synergy in their marketed EBITDA, ranging from 0.8% (International Design Group) to 31.8% (Cedacri). Some 14 deals market revenue or profit synergies, from 0.2% (Foncia) to 15.5% (PeopleCert).

Pfleiderer manufactures engineered wood products and resins, and has identified some €11.8m in cost savings and a further €11.6m in EBITDA from new pricing strategies and initiatives. These initiatives include price differentiation (one for the economists) and the inability of sales staff to manually override new pricing rules - unless approved by the COO. The group budgets an €8.6m EBITDA uplift from the new pricing rules, but this is based on a hypothetical full year impact, and after just two months of actual results, it’s unlikely any decrease in demand could really be identified. On an unrelated note, laminate flooring producer Classen filed a case against Pfleiderer seeking damages of €55m on overpricing from 2002-2007, after the German Federal Cartel Office imposed penalties against the company (among others) for its part in the “Chipboard Cartel”.

Professional qualification and examination group PeopleCert include €15.4m of synergies (15.4%), of which €9m are anticipated from increased revenue, the most notable being a new ‘mandatory book policy’ across exams, moving toward direct publishing of examination books, cutting out third party providers (especially where these will be higher margin e-books). An expected one-off cost of €0.9m needed to be incurred (for example to cancel publishing contracts) has not been factored in.

Given that we’re at most seeing two quarters of financial data since these deals were marketed, it’s too early to tell how effective or accurate these synergies might be, but as this S&P report into add-backs outlines, corporates on average miss projections by ~35%.

Category E: Covid add-backs

We last looked at Covid add-backs in April this year. So how has the picture changed over the last five months?

As you might expect, half of these add-backs came from the consumer discretionary space (14 of 29 deals), where shuttered restaurants and stores, social distancing, and travel restrictions held back core customers. Part of this can also be explained by the relative overweighting of these deals, which year to date made up around 27% of new issuance (compared to an average of 18% in the prior three years). The remainder of add-backs were split evenly across all other industries (excluding communication services).

We’ve spoken about Coty before, and it’ll come as no surprise to see it top the list of adjustments here. The majority of the adjustments are the more aggressive ‘lost revenue’ type - here permitted under one of many new “pandemic-proof” EBITDA clauses". Alain Afflelou ‘normalizes’ lost EBITDA by ignoring the H1 2020 results and substituting the affected period for pre-pandemic 2019 results. Blood plasma group Kedrion meanwhile takes a more typical route, adding back a host of additional costs, including increased donor fees, personnel costs and higher input costs.

Not all add-backs are positive however. As previously mentioned, laboratory firm BioGroup LCD adjusted downward a €73.3m contribution from increased testing activity (although they deem €5m of this recurring) and fellow laboratory group Cerba had a -€86.3m adjustment for similar reasons. French retailer BUT was the only other firm to ‘normalize’ EBITDA downward; mostly related to exceptionally high sales volumes, lower staff costs, and less advertisement. These are positive steps in transparency, and while many deals adding covid costs back do reportedly net the difference, disclosure is still limited, and estimates are left to management discretion.

And finally, another attitude taken (often by those worst affected, who couldn’t physically market deals on negative leverage) was to use pre-covid data. These issuers include: Stonegate Pubs, APCOA Parking, Ikos, Pizza Express, Elior, NH Hotels, Punch Taverns, David Lloyd, Center Parcs, Dufry, and Douglas. These names have been excluded from the above sample, as they are not directly comparable.